2013 will be remembered as the year Islamic finance cemented its importance as an alternative funding source and shook off any lingering scepticism that its appeal was merely as a transitory safe haven.
“It was not a year of radical change but one of continual development,” says Matthew Sapte, a partner at law firm Dentons in London, “However, new markets are opening up. We are seeing the sukuk show take-off in Turkey. And 2014 promises much in terms of potential issuance in Africa and Europe.”
The Turkish government confirmed its commitment to Islamic finance with a $1.25bn sovereign sukuk in October, while all four participation banks — as Islamic banks are known in the country — issued. Corporate sukuk are yet to be seen in Turkey but are expected in 2014, with the likes of construction firm Agaoglu eyeing deals.
Corporate sukuk remains rare even in the Gulf Cooperation Council, although Emirates Airline and Saudi Electricity Co established themselves as regular first quarter issuers, with $1bn and $2bn respectively. The year saw debuts by Ooredoo (formerly Qtel) for $1.25bn and GEMS Education ($200m), as well as the return of real estate companies Aldar Properties ($750m) and Dar Al Arkan ($450m and $300m) after several years of absence.
“While the market for non-regional issuers is still in a nascent stage we should expect to see the reach of international issuers into both US dollars and local currency grow just as we are seeing the growth of the dedicated Islamic investors situated across the Middle East, Asia and Europe,” says Spencer Maclean, head of syndicate, West, at Standard Chartered in London.
Outside the Gulf, Malaysia is a prime candidate to issue dollar sukuk in 2014, as it has a $1.5bn five year dollar sukuk maturity in August. Sime Darby’s tightly priced $800m sukuk in 2013 points to greater engagement in international markets by Malaysian borrowers, which have mainly stayed domestic so far.
Hopes for sovereign sukuk debuts in North African countries — particularly Egypt — have not yet been realised, but Morocco and Tunisia remain prospects for the first quarter. South Africa is also slated for a first quarter dollar debut, having stalled its plans since 2012.
But the year’s biggest prize could be the UK’s commitment, made in October, to issue a sovereign sukuk in 2014 — a breakthrough that has opened up Islamic finance to a much wider audience. Its visibility could help spur Western blue chip corporates to add sukuk to their funding tools — something that hasn’t been seen since General Electric issued $500m in 2009.
“The key requirement for the international sukuk market is a more diverse range of issuers,” says Nigel Denison, head of wealth management and treasury at Bank of London and the Middle East. “In particular it would be good to see other international corporates follow GE’s lead and issue sukuk.”
Volume isn’t everything
The successes of 2013 are not easily told in figures. 2012 was a hard act to follow, with record breaking sukuk issuance, an unhindered rally and jumbo deals. Its $150bn of global deals, including $19.3bn in dollars, dwarfed previous years, but also came amid eurozone financial chaos and a heavy redemption calendar.
Global sukuk issuance in 2013 had reached just $110bn in November, according to EuroWeek’s Islamic Finance Information Service. Malaysia ended 2013 with a burst of activity (one senior official says it was the busiest quarter his bank has ever seen) but domestic ringgit volumes were greatly down on 2012. The fall from $113.4bn to $74.6bn was affected by both the country’s close run May 5 general election and the general market sell-off in late May.
The dollar sukuk market started 2013 well, with $4.8bn of issuance in the first quarter and $5.7bn in the second. But concerns over US Federal Reserve stimulus tapering and rising rates caused a prolonged sell-off from the end of May that hit emerging bonds and sukuk particularly hard — leaving many investor portfolios under water for the year and curbing demand for new issues.
While similar factors could affect sukuk in 2014, investors say the market is in good shape.
“The tapering issue and pressure on EM really shut down the primary market for much of the third quarter,” says Mohieddine Kronfol, chief investment officer at investment firm Franklin Templeton in Dubai. “So if you have events that abruptly shut financial markets it will naturally affect sukuk.”
Most GCC sovereigns are well positioned and have dependable spending plans, he adds, with growth numbers that compete with EM.
UK makes bold entrance
The UK’s plans to issue a debut sukuk set a bullish tone for the coming year, although the initial deal size is expected to be small (just £200m). The immediate beneficiaries of a UK sovereign sukuk would be the country’s Islamic banks, which have only had one source of highly rated sukuk — the Islamic Development Bank — that is eligible for their liquid asset buffers, as required by regulators.
“It is excellent news that [UK prime minister] David Cameron has announced the UK government sukuk,” says Denison. “This means that the UK Islamic banks will have a sterling denominated liquid instrument that will go some way towards creating a level playing field with conventional banks.”
But the UK’s support also may mean sukuk will hit the radars of corporate financiers and CFOs at major blue chip firms as a viable means to diversify their funding.
“When you see a new sovereign issue there is always the hope that companies will follow,” says Kronfol. “With Turkey we saw four banks follow but no independent corporates yet — it could happen over the next year though. With the UK, follow-on issuance may not happen quickly, but with a longer term view we would certainly expect significantly more issuance.”
France, Ireland and Luxembourg have also been rumoured to be looking at sukuk debuts over recent years.
“The announcement by the UK government of its intention to issue a sukuk is potentially a defining moment in the history of Islamic finance,” says Richard De Belder, a partner at Dentons in London. “This development will hopefully encourage other Western countries to also consider issuing sukuk and generally encourage and promote Islamic finance in their countries.”
European blue chip and sovereign sukuk are likely to be some way off, but mid-cap company issuance and sukuk to support infrastructure projects are much closer, say market participants. UK social housing is one area that will benefit from the UK’s sovereign announcement in 2014, according to real estate investment firm 90 North.
“While the announcement of the government’s intention to launch a sukuk is clearly very significant in its own right, what excites me is the momentum that could be generated from this,” says Philip Churchill, partner at 90 North in London.
“Real estate is perfect collateral to secure sukuk issuances and 90 North is already considering suitable real estate asset classes and strategies to secure successful launches in the future, including long leased social infrastructure properties.”
There are compelling reasons why sukuk should gain popularity with corporate treasurers and CFOs in the coming year. They have become as easy to price and document as conventional bonds.
This means there is a growing opportunity to show that Islamic finance is cost-effective for companies to raise capital and diversify their funding sources. Utilities, real estate investment vehicles, aviation, oil and gas and infrastructure are all sectors that lend well to this.
So far, investment grade blue chip CFOs have had easy access to credit, particularly in an era of quantitative easing — and little incentive to look beyond conventional markets. But perceptions that Islamic finance is complex and expensive are no longer accurate as legal documents are standardised under English law for common structures, says Noel Lourdes, executive director at Amanie Advisors in Dublin.
“The majority of fees can even be structured on a ‘no foal no fee basis’ for investment grade entities,” says Lourdes. “Therefore it costs little to explore — perhaps the price of an air ticket and hotel accommodation to meet the investors.”
Middle East and North African countries such as Bahrain, Egypt, Jordan, Morocco, Oman and Tunisia all looked contenders at the start of 2013 to hit the market with sukuk but none has yet brought a sovereign deal.
“Morocco is the most likely of the North African countries to issue sukuk first,” says Kronfol. “It has a letter of credit with the IMF, but has indicated it wants to come to the market and spreads have compressed for their conventional bonds.”
In May, Morocco increased its outstanding $1bn 4.25% conventional 2022s and its $500m 5.5% 2042s by 50% each, bringing the tranches to $1.5bn and $750m, respectively. Morocco has also budgeted for as much as $1.5bn of issuance this year to help cover its budget deficit.
Oman has made good progress with introducing Islamic finance and banking since late 2012. Authorities have made plans to issue a sovereign sukuk and this is likely to take place in 2014.
The biggest spur to sukuk in the coming year is likely to be its growing investor base — which is already starved for product.
“2014 will see new entrants into Islamic asset management, whether new providers or individual funds,” says Jason Kabel, head of fixed income at Bank of London and the Middle East. The catalyst will be the sukuk market and growing demand for pensions and savings products in the GCC.
“Given Dubai’s aim to become the capital of the Islamic economy it is likely that many of these funds will be run out of Dubai and the DIFC,” he says. |